JMAR

Volume Thirteen
2001

The Impact of Activity-Based Costing

Techniques on Firm Performance
Tom Kennedy
University of Limerick
John Affleck-Graves
University of Notre Dame
Abstract: Given the debate in both the professional and scholarly literature on the
effectiveness of management accounting systems in the contemporary business environment, there is a need to understand more about the impact of activity-based costing
(ABC). In this paper, we show ttiat the choice of a management accounting system,
such as ABC, may have a significant impact on firm value. Specifically, for a sample of
U.K. firms, we show that firms adopting activity-based costing techniques outperform
matched non-ABC firms by approximately 27 percent over the three years beginning on
January 1 of the year in which the ABC techniques are first implemented. This result is
robust to different matching criteria and for both accounting and market-based measures of performance. Further analysis suggests that ABC adds to firm value through
better cost controls and asset utilization, coupled with greater use of financial leverage.

Keywords: activity-based costing; abnormal returns; holding period

returns; firm performance.

INTRODUCTION
The availability and relevance of accounting information underlies many business decisions. In recent years, traditional volume-based cost models have been
the subject of much criticism, especially in relation to the accuracy of product
costing. The popularity of activity-based costing (ABC) in the mid-1980s and the
subsequent evolution {Bromwich and Bhimani 1989) vs. revolution (Johnson and
Kaplan 1987) debate has enriched both the management accounting literature
and practice. Research to date, however, has concentrated on assessing the integrity of the ABC process (for example, Foster and Gupta 1990; Noreen 1991; Roth
and Borthick 1991; Banker and Johnston 1993; McGowan 1998; Maher and
Marais 1998); examining its application and implementation in a single case study
situation (for example, Cooper and Kaplan 1999); assessing the degree of interest
and adoption (for example, NichoUs 1992; Armitage and Nicholson 1993; Innes
and Mitchell 1995, 1997; Malmi 1999); and factors impacting the success of implementation (for example, Anderson 1995; Shields 1995; Foster and Swenson 1997;

This paper has benefited from the helpful comments of Roger Mills, Robert Kaplan, Ram Ramanan,
Eamonn Walsh, and seminar participants at Florida State University, the University of Kentucky, and the
University of Notre Dame. We gratefully acknowledge comments from two anonymous remewers and the
editor in revising this paper. Any remaining errors are the sole responsibility of the authors. The financial
support of the University of Limerick is also acknowledged.

20

Joumal of Management Accounting Research, 2001

Anderson and Young 1999). Despite the assertion of Cooper and ICaplan (1992) that
"the goal of ABC is to increase profits, not to obtain more accurate costs," little
attempt has been made to examine empirically the relationship between the adoption of ABC and the creation of shareholder value through increased profits.
Therefore, the prime purpose of this paper is to see whether the many documented
successfiol case study implementations of ABC are, on average, translated into
superior stock perform,ance.
Using mail surveys, we identify a sample of 47 firms listed on the London
Stock Exchange (LSE) that adopted ABC between January 1988 and February
1996. We also identify 183 firms that had not adopted ABC before the end of
February 1996. We match each adopting firm at the beginning of the year in which
they first adopted ABC with a non-adopting firm from the same industry and of
approximately the same market capitalization. Despite the limited number of
confirmed non-adopters in our sample, we were able to match 37 of the 47 ABCadopting firms within a reasonable level of accuracy. Next we computed buy-andhold returns for the ABC-adopting firms and their matched counterparts for the
three-year period beginning in the year of adoption and continuing for the subsequent two years. Our results reveal a three-year return of 61 percent for the ABCadopting firms, compsired to 34 percent for their non-adopting counterparts, the
difference being significant at the 5 percent level.
We perform several robustness checks on our data. First, we use nonparametric methods to confirm that the proportion of ABC adopters that outperform their
matched counterparts is greater than 50 percent. Second, we use two alternative
matching criteria, one based on market-to-book ratio, the other on net total
assets. Third, we use Ritter's (1991) cumulative abnormal return (CAR) method as
an alternate to the buy-and-hold method to measure abnormal returns. Fourth,
we use the FTSE-100 index as a market surrogate to compute market-adjusted
returns rather than matched-firm-adjusted returns. Fifth, we review the two-year
pre-adoption market performance of both the ABC firms and their matched counterparts in order to test for the overreaction/underreaction phenomena. Our
results show that there was no difference in the performance of our ABC firms and
their matched counterparts prior to the adoption of ABC. Finally, we report the
difference between the ABC firms and their matched counterparts under a range
of accounting-based measures of performance. In all cases, we find evidence of
significant superior performance by the ABC-adopting firms.
As with many cross-sectional studies, our results must be interpreted with
caution. Other factors, unknown to us but common to our 47 ABC-adopting firms
may be the underlying cause of the superior performance we document. We
attempt to address these concerns by examining company announcements in the
period surrounding the adoption of ABC. We fmd no difference between our ABCadopting firms and their matched counterparts, either in the year before, or the
three years following the adoption of ABC, in terms of significant corporate events
such as new capital raised, acquisitions, and divestitures. It is possible however,
that the implementation of other strategic initiatives that coincide with the adoption of ABC may be the cause of the abnormal returns we document. Thus, despite
the strong and robust evidence in this paper, it is not possible to prove definitively
that there is a causal link between ABC adoption and subsequent increases in
shareholder value.
The structure of the paper is as follows. Section two presents a brief review of
the ABC literature and a summary of the attributes and characteristics of ABC, as
interpreted in this study. It also sets out the hypothesis and the theoretical model
underpinning this study. Section three documents the research method and data

Kennedy and Affleck-Graves

21
source used. Section four presents the research findings. Section five summarizes
the results of the robustness tests. The paper concludes in section six with a
summary and interpretation of the findings, as well as a discussion of the limitations of the study.

LITERATURE AND HYPOTHESIS DEVELOPMENT

This study examines the link between implementation of an activity-based
costing system and the Shareholder Value Analysis (SVA) framework of Rappaport
(1986). This linking of ABC to value creation is depicted in Figure 1.
Given the SVA framework of analyzing how business decisions affect "economic value" through the identification of the key value drivers (Wenner and Le
Ber 1989), ABC can provide information crucial to an understanding of how a
firms' competitive advantage is generated. Shank and Govindarajan (1993) highlight such an approach by asking two questions: is the activity necessary, and is
the activity performed efficiently? They label this approach as "value engineering
the cost structure." By more accurately attributing cost to products, services, and
customers, ABC can play an important role in providing relevant information for
management operating decisions, which, in tum, should impact on profitability
and, ultimately, shareholder value. Ward and Patel (1990) also suggest that ABC
provides a sound foundation for future cash flow projections. They argue that this
leads to investment in value-added activities that support products, services,
customers, and market segments, thereby increasing shareholder value.
The Schrader Bellows (Cooper and Weiss 1985), John Deere Component Works
(Kaplan 1987) and Tektronix (Cooper and Tumey 1988) cases were the "original"
ABC systems to be documented in detail. The concept has been further developed
by the application of Activity Based Budgeting (Morrow and Connolly 1991), Activity Based Management (Campi 1992; Tumey 1992), Activity Based Computing
(Bentley 1993), Activity Based Cost Management (Clarke 1994), and its full infusion into the business process re-engineering framework (Brimson and Fraser
FIGURE 1
The Link between ABC and Market Value
Adapted from Ward and Patel (1990)
EfTicient
Market
Hypothesis

Produc I/service,
ctulomer and
market profitability
inrormation

business's
acciviiies

Investment
Decisions

ABC
Techniques

Profit and
Cashfkiw

\
Financial and
nonfinancial
peifonnancc
measures

Operating
Dee is ions

Market
Vakie

Objective
o f Finn

A more equitaole allocation of overheads

An ability to deal with a complex and opaque cost base
An ability to integrate non-accounting aspects
A control device

22

Joumal of Management Accounting Research, 2001

1991). The activity-based approach has also been used as a base for applications
such as benchmarking, cost reduction, and transfer pricing (Morrow and Ashworth
1994). Further, the evolution of the "balanced scorecard" concept (Kaplan and
Norton 1992), and its subsequent refinement as the organization's central management system (Kaplan and Norton 1993; Hoffecker and Goldenberg 1994),
contextualizes the application of ABC.
Even though the ABC concept was initially developed in a manufacturing
context, it can be applied equally well in the services sector, as activities are
universal to all organizations. Cooper and Kaplan (1992) and King et al. (1994)
document successful applications in the telecommunications, transport, wholesale and distribution, marketing, health, and information services sectors. Innes
and Mitchell (1997) document its successful application in the U.K.'s largest
financial institutions.
Malmi (1999) cautions that there is no common view of what makes an accounting system an ABC system. For the purposes of this study, we therefore
regard ABC as a generic term to describe in altemative paradigm to traditional
volume-based cost models with the following key attributes:
(1) a more equitable allocation of overheads by identifying the underlying
"driver" of activities;
(2) a "new technology^ capable of dealing with an increasingly complex and
opaque cost base;
(3) a process of activity identification with the ability to integrate nonaccoiinting
aspects; and
(4) a control device in the spirit of "panopticon" and built upon the knowledge
created through the management information system.
Within this framework ABC can be viewed as a cost and performance management
model capable of contributing significantly to operational improvements and strategy formulation (Kaplan and Cooper 1998). It is also consistent with Porter's
(1985) value-chain concept and its development by Shank and Govindarajan
(1993) in a strategic management accounting context.
Gosselin (1997) notes that despite the perceived advantages of ABC and the
interest shown by academics and management accountants, adoption has not
been intense (for example. Institute of Management Accountants 1993 [U.S. evidence]; Armitage and Nicholson 1993 [Canadian evidence]; Innes and Mitchell
1995 [U.K. evidence]). Moreover, Homgren (1990) and Nanni et al. (1992) provide
evidence on some firms that have stopped the implementation process. Gosselin
(1997) terms this the ABC paradox, namely, "if ABC has demonstrated benefits,
why are more firms not actually employing it?"
There are several potential answers to this paradox. First, ABC may not be
suitable for every firm. A large strand of recent research shows that successful
implementation depends on many aspects. For example, Anderson (1995) and
Malmi (1997) argue that successful implementation depends on organizational
and technical factors, with Anderson and Young (1999) citing supporting evidence
from studies such as Chenhall and Langfield-Smith (1998), Foster and Swenson
(1997), Knimwiede (1998), and Shields (1995). Similarly, Malmi (1999) argues that
adoption depends on several factors including firm size, production lype, degree of
centralization, product diversity, and the ratio of indirect to total costs. Finally,
Gosselin (1997) suggests that specific characteristics in their business strategy
and organizational structure lead certain firms to adopt and implement ABC and,
by implication, other firms not to implement ABC.

Kennedy and Affleck-Graves

23
Second, ABC may not, per se, add value, but may merely be correlated with
other variables that are the true value drivers. Alternatively, the control system may
have an indirect rather than a direct effect on performance through m intervening
variable that mediates the relationship between the control system and the performance measure (Shields et al. 2000). For example, Piper and Walley (1990) claim
that the advocates of ABC only show success stories and in so doing attribute ill or
most of that success to one itemthe ABC system. They describe this as a "logical
fiction" as, in reality, any result is due to a number of separate, different, concomitant events and to attribute blame or credit to one particular reason is not always
correct. They conclude by saying that ABC does not stand up to close scrutiny
because it has not yet been empirically tested or logically established. Later, Piper
and Walley (1991), in reviewing some of the early case studies (Siemens, John Deere
Component Works, and Tektronix [Cooper and Kaplan 1999]), posit a counterthesis, namely, that it is strategic decisions and not activities that cause costs.
Bromwich and Bhimani (1994), in comparingABC toother cost systems, traditional
or otherwise, contend that the "superiority of one costing system over smother
cannot be established unambiguously." They propose that ABC has not succeeded
in addressing the problem of the "overhead blob" because it does not absorb the
"facility sustaining costs" into products. They conclude that "the evidence and
arguments advanced by advocates of wholesale change in management accounting
are not yet sufficient to justiiy the wholesale revision of management accounting."
Third, little evidence has been presented that documents a direct link between
a change to an ABC system and increases in either shareholder value or firm
profitability. As Gordon and Silvester (1999) conclude, adoption of ABC has to be
seriously questioned if a positive market effect cannot be clearly established.
Absent such a link, many firms may be reluctant to change to an ABC system that
requires considerable investment. For example, Bromwich and Bhimani (1989)
argue that even though "it is known that activity costing changes product costs
substantially, there is as yet little to suggest that it enhances profitability." Innes
and Mitchell (1990a) support this view by stating unequivocally that there is "no
evidence to date that ABC improves corporate profitability."
This study focuses on the third potential explanation of Gosselin's (1997)
paradox, the existence of a causal link between the introduction of ABC and firm
performance. A large literature has evolved examining the impact of specific events
such as management choices or decisions on firm value. Such studies are generally referred to as event studies and early examples include earnings announcements (Ball and Brown 1968), stock splits (Fama et al. 1969) and seasoned equity
offerings (Asquith and Mullins 1986). The widespread use and acceptance of the
event-study method has, in tum, led to a well-established research methodology
(Brown and Warner 1980, 1985).
Most event studies have focused on events that are easily identified and where
a clear adoption date can be established. A few studies, however, have attempted
to examine the effect of strategic management choices on firm performance in
cases where it is difficult to specify the exact date of implementation. For example,
Haka et al. (1985) examined value implications following the adoption of discounted cash fiow capital budgeting techniques and found no evidence of superior
market performance for firms adopting these sophisticated techniques. In contrast, Easton and Jarrell (1998) found compelling evidence that implementation of
Total Quality Management (TQM) is associated with superior long-term performance using both accounting- and market-based measures of performance.
Gordon and Silvester (1999) do use an event-study approach in examining the
impact on firm value of an announcement that the firm was using ABC. Their study

24

Joumal of Management Accounting Research, 2001

examines the performance of ten firms identified as ABC users in a May 30, 1988
article in the magazine, Business Week. While the ABC firms do have positive abnormal returns on the publication date, so do ten size- and industry-matched control
firms. As the difference in the returns to the ABC firms is not significantly different
(at conventional levels) from their matched counterparts, Gordon and Silvester
(2999) conclude that the announcement of ABC use does not affect firm values.
In summary. Cooper and Kaplan (1992) argue that the ultimate aim of ABC is
to increase profits. The associated literature suggests that provided the techniques are implemented effectively, with the support of ail, then increases in sales
and/or reductions in expenses should follow. Given these profit implications,
additional value should accrue to those firms that adopt the techniques. The
general hypothesis examined in this study is, therefore:
Ho: There is no difference in the performance of a portfolio of firms
adopting ABC when compared with a set of matched firms that do
not employ ABC.

RESEARCH METHOD AND DATA

Strategic discretionary decisions, such as a change to an AE;C system, introduce three special problems to the event-study method. First, it is difficult to
specify an exact event date. Firms do not usually announce the cliange to an ABC
system, and the feasibility phase and subsequent implementation can take many
months, or even years. Second, because of the lack of a specific public announcement related to the event, the market may take time to learn of the introduction
and hence to reflect a change in valuation. As Gordon and Silvester (1999) suggest, the market may not fully understand the implications of the adoption of ABC
and it may take an external event (such as the Business Week article in their
study) to bring this information to the attention of the market.
Consequently, stock price reaction to the introduction is likely to be gradual
and may last for an extended period of time. It is also likely to extend for different
periods for different companies. Third, as Barber and Lyon (1997) show, abnormal
returns computed over extended periods can be severely biased. In the subsections below, we describe how we attempt to address each of these problems.
Sample and Data Collection
The top 1,000 firms in the U.K. as listed by The Times 1,000 (1995) (ranked by
turnover) and The Times 1,OOQ (1996) (ranked by capital employed^) were chosen
as the appropriate sample frame. We integrated both listings due to the change in
ranking criteria that had been adopted for those two years. This minimizes the
bias in favor of manufacturing firms and results in the inclusion of a greater
number of financial sector firms in our sample. Fincdly, as share price returns
were used as a proxy for firm performance, we excluded firms not publicly listed.
This resulted in a final population of 853 firms.
This sample frame was chosen because of its accessibility, the maturity of its
financial market, and previous research demonstrating strong interest in ABC
systems (Innes and Mitchell 1995). It also reflected the view of Cobb et al. (1992)
that as the implementation of ABC caused a "considerable drain on accounting
resources," they would be considered more seriously by larger firms than smaller
Defined as "shareholders funds plus long term loans (where separately disclosed) plus intra-group
payables plus deferred liabilities less (for insurance compEinies) technical reserves* (The Times
1,000 1996).

Kennedy and Affleck-Graves

25
firms. In addition, as the phenomenon in an applied state was of fairly recent
origins, the firms with the greatest access to resources of people or technology and
those engaged in ongoing strategic evaluations were the most likely to have given
it serious consideration.
A mail questionnaire survey was used to establish those firms that had (or had
not) adopted ABC and when the adoption took place. It also asked if any of the
adopting firms had subsequently abandoned ABC. There is no universal agreement on what makes an accounting system an ABC system (Malmi 1997). We
therefore follow Malmi and allow the firm to identify if they used ABC and, if so, the
year in which it was first adopted. Specifically, we classify any firm that indicates
the use of any ABC technique as an ABC firm for the purposes of our study.
We began by testing the survey instrument using a sample of Irish firms. Then
we determined the name of the finance director at 555 of the 853 U.K. sample
firms. To improve the response rate, we included a cover letter to these 555
finance directors, by name, setting out the reason for the study, its practical
value, and emphasizing the importance of a large response. This is similar to the
procedure discussed in GosseUn (1997). For the remaining 298 firms where we
were unable to determine an individual name, the cover letter was directed to the
"Finance Director." In addition, the cover letter assured each respondent of complete confidentiality, promised to send respondents the aggregate results, sind was
personally signed by one of the authors. A self-seal, prepaid envelope was included
and a reply fax number was also provided. A specific response date of Friday,
March 22, 1996 was highlighted on the cover letter, after which a telephone
follow-up exercise took place. This telephone follow-up exercise concluded on
Friday June 14, 1996. The Appendix provides a copy of our questionnaire.
In conducting the telephone follow-up process, up to four attempts were made
to reach the potential resp>ondent in each firm. During this process, a number of
firms were unable to locate the survey documentation and asked for another copy.
Forty-five follow-up letters and questionnaires were sent during this phase of the
project. By the end of the process, 1,696 telephone calls had been logged.
19.2 percent of those surveyed responded via mail and 75.6 percent responded
by telephone/fax, giving a total response rate of 94.8 percent. However, while 94.8
percent of the sample firms were explicitly contacted, either through the mail
survey or telephone call, only 27.4 percent (n = 234) answered the questionnaire
in sufficient detail to facilitate further analysis. Further, by dating the postal
responses and keeping a record of the daily telephone calls, we were able to
compare the respondents over time (Oppenheim 1992). We found no significant
difference between those firms that responded early and those that responded
late, and conclude that there is no evidence of nonresponse bias in this study.
Table 1 provides a breakdown of all respondents for this study, the Innes and
Mitchell (1995) and Innes et al. (2000) studies. Analysis of the reasons for failure
to complete the questionnaire shows that of the total sample, 34.2 percent were
"too busy* to respond, 23.8 percent had a specific policy not to respond to surveys,
6.3 percent indicated they were unlikely to respond and, finally, 3.1 percent of the
responses were unusable. Removing all responses that were unusable or incomplete left 234 firms available for further analysis. Of these, 47 firms (20.1 percent)
used ABC, in contrast with 49 firms (19.5 percent) found in the Innes and Mitchell
(1995) study and 31 firms (17.5 percent) in Innes et al. (2000). In addition, 187
firms explicitly identified themselves as non-ABC users.
Figure 2 indicates the year in which each of the 47 ABC-adopting firms first
introduced the concept. Given the interest that the concept generated in both the
academic and professional communities in the late 1980s, a significant

Joumal of Management Accounting Research, 2001

26

TABLE 1
Analysis of Survey Results
This Study

Analysis of
Respondents

ABC users
Non-ABC users
Total-usable responses
Too busy
Policy not to respond
Unlikely to respond
Unusable
Other
No response
Total Sample Size

47*
187

234

Innes and
MitcheU (1995)

5.5

49*
202

21.9
27.4

292
203
54
26
NA
44

34.2
23.8

853

251

6.3
3.1

5.2

23
51
NA
31
83
561

100

1,000

Innes et al.
(2000)

4.9

31*
146

20.2
25.1
2.3

177

%
4.0

18.8
22.8

56.1

NA
NA
NA
32
139
427

17.9
55.1

100

775

100

5.1

3.1
8.3

4.1

* 20.1 percent. 19.5 percent, and 17.5 percent of total usable responses, respectively.
FIGURE 2
When was ABC Introduced?

1988

1989

1990

1991
1992 1993
Year of Introduction

1994

1995

1996

implementation rate was to be expected in the early 1990s. The results of our
survey indicate that this was achieved primarily in the years 1992 to 1994. It is
also important to note that none of the respondents to our survey indicated that
they had introduced and subsequently abandoned the ABC approach.
The Matching Process
Our main results are based on a comparison between the ABC-adopting firms
and a matched sample of similar, but non-ABC firms. This is similar to the
approach followed by Gordon and Silvester (1999). From our survey, we identified
47 firms that had adopted ABC, together with the year of adoption for each firm.
We also identified 187 firms that had not adopted ABC. As Easton and Jarrell

Kennedy and Affleck-Graves

27

(1998) note, the use of control firms is critical to control for common factors that
effect similar types of firms in the performance measurement period and are not
related to the adoption of ABC.
The precise time of the introduction of ABC is not an easily discernible event,
unlike, for example, an acquisition decision or an earnings announcement. Consequently, there is not a specific, easily identified date that can be associated with
the introduction of an ABC system. Both our survey and the Innes and Mitchell
(1995) survey found that firms consider the adoption of ABC over a period of time,
often with the assistance of external consultants. Even sifter deciding to adopt an
ABC system, it can take many months of planning and development before the
system is finally implemented. Because of the difficulty in establishing an exact
event date, we follow Haka et al. (1985) and choose January of the year in which
the firm indicated they first used ABC as the adoption date. All performance
comparisons are done relative to this January date.
Because firms seldom make a specific public announcement of a change to an
ABC system, an instsmtaneous response to the introduction would not be expected. Hence we do not use a standard event study approach. Rather, we use a
performance assessment window of three years to capture the effect, if any, of the
introduction on firm performance. This recognizes the time it takes to fully implement such a system and the potential "lag" effect discussed in other studies such
as the TQM study of Easton and Jarrell (1998) who examine five-year post-event
performance, and Haka et al. (1985) who use a 48-month period to examine the
impact of a change in capital budgeting methods. It is also consistent with the
growing literature on long-term trends in stock market prices (for example, Ritter
1991; Spiess and Affleck-Graves 1995). While most empirical evidence of this
latter phenomenon is from the U.S., Levis (1993) has shown similar evidence for
the U.K. stock market, the database chosen for this study.
We matched firms on December 31 in the year prior to the adoption of ABC.
Three different matched samples were established, based on market capitalization, market-to-book ratio, and net-total-assets. Market capitalization was used to
control for firm size, a variable that Banz (1981) and others have shown is related
to stock returns. Matches by market-to-book were used in response to the findings
of Fetma and French (1992) and net-total-assets was used as a size measure of
balsince sheet value. Throughout the exercise, no firm was used more than once as
a matched firm within a three-year time frame.
The specific matching procedure was as follows.
(1) ABC firm i was matched with all non-ABC firms in the same level 4
(Datastream) industry classification and within 25 percent of its market
capitalization. If more than one match was found, then the non-ABC firm
with the market capitalization closest to firm i was chosen as the match.
(2) If no match was found in the level 4 industry classification within 25
percent, the process in (1) was repeated using the level 3 industry classification. If no match was again found, then the process was repeated at level 2.
(3) If no match within 25 percent of the market capitalization of firm i could be
found in the 187 non-ABC firms, then the entire process was repeated
using 50 percent of the market capitalization of firm i.
This procedure gave first priority to the market capitalization difference and
secondary status to the industry-level match. Similar procedures were used to
identify the market-to-book and net-total-assets matched samples. The final market capitalization-matched sample contains 37 firms, while the market-to-book
and net-total-asset samples contain 38 and 33 firms, respectively.

Joumal of Management Actxtunting Research, 2001

28

Table 2 presents an industry profile of the three sets of matched ABC sample
firms, based upon Datastream level-3 industry classification codes. It reveals that
all the major industries in the U.K. economy are represented and confirms that
the process has also been applied outside the manufacturing sector. The results of
the three matching procedures are summarized in Table 3.
It is worth noting from Table 3 that 76% of the firms in the case of market
capitalization, 84% in the case of market-to-book and 82% in the case of net-totalassets were matched within the level 3-industry classification,^
Descriptive statistics indicating the accuracy of our matching procedure are
presented in Table 4. They show that the market capitalization data set achieved
the best match as there were no statistically significant differences (at the .10
level) between the ABC and non-ABC firms in terms of mean market capitalization, market-to-book ratio, or net-total-assets.
We also used the less onerous restriction of matching within 75 percent of market capitalization
and going to industry level 1. This increased the market capitalization-matched sample size by 6
firms (0 and 1 in the case of the market-to-book and net-total-assets samples, respectively). All
results are qualitatively the same between the larger sample and the results we report using the
smaller sample size.
TABLE 2
Profile of ABC Matched Sample Firms
Description
(Level 3)
General Industries
Utilities
Financials
Consumer Goods
Services
Total

Market
Capitalization
No. Firms

14

37.84
18.92
16.22
18.92
8.11
100.00

7
6
7
3
37

Market-to-Book
%
No. Firms
11
9

8
8
2
38

28.95
23.68
21.05
21.05
5.26
100.00

Net Total Assets

No. Firms

10
7
5
8
3
33

30.30
21.21
15.15
24.24
9.09
100.00

TABLE 3
Summary of Matched Sample Process
Industry
Level

Matched
within %

No. Firms
Matched

% Firms
Matched

Cumulative %
of Sample

Panel A: Market Capitalization :Sample (37 firms)

25%
4
10
25%
18
3
25%
9
2
37
Total
Panel B: Market-to-Book Sample (38 flrms)
4
25%
18
25%
14
3
25%
5
2
1
3
50%
38
Total
Panel C: Net-Total-Assets Sample (33 firms)
4
25%
11
16
25%
3
2
25%
6
33
Total

27
49
24

27
76
100

100
47
37
13

47
84

97
100

100
33
49
18
100

33
82
100

29

Kennedy and Affleck-Graves

TABLE 4

Mean Comparison >of ABC and Non-ABC Samples

ABC Firms

Non-ABC

Firms (Mean)
Match Criteria
(Mean)
Panel A: Market Capitalization Sample (37 firms)
Market Capitalization
1,504.35
1.421.68
Market- to- Book
2.61
3.41
Net-Total-Assets
861,740
955,447

Panel B: Market-to-Book Sample (38 firms)

Market-to-Book
2.51
2.31
Market Capitalization
3,413.89
824.62
Net-Total-Assets
1,712,543
512,186
Panel C: Net-Total-Assets Sample (33 firms)
Net-Total-Assets
955,896
887,901
Market Capitalization
2,167.50
1,714.55
Market-to-Book
2.66
2.50

Difference
(t-statistic)
1.1815
-0.4817
0.6642

p-value
.1226
.3167
.2557

1.4401
2.4814
2.5584

.0791*
.0089**
.0074**

1.5757
0.6442
0.2872

.0625*
.2620
.3879

", ** Statistically significant at 0.10 and 0.05 levels, respectively.

The market-to-book data set is not as well matched with respect to all three
criteria, especially market capitalization and net-total-assets. In this case, the
ABC firms tend to be larger, which may bias the results shown later in Section
four. The net-total-as sets data, set of 33 firms is reasonably matched against the
market capitalization and market-to-book criteria, but the ABC firms have larger
net-total assets on average (at .10 level).
The overall result of the matching process is that high-queility matches were
achieved for both the market capitalization and net-total-assets data sets. Caution
is suggested in regard to the market-to-book data sets due to the less than
satisfactory secondary matching results.
Performance Analysis
As Anderson and Young (1999) note, success in ABC implementation is multidimensional and one needs to be careful in addressing the question of what
constitutes success. In this study, we use a narrow definition of "success" that is
consistent with fmance theory and the goal of shareholder wealth maximization,
namely an increase in shareholders' wealth as measured by stock returns {Haka et
al. 1985). As Easton and Jarrell (1998) note, stock returns provide "a comparatively 'clean' overall performance measure." It is important to stress that other
measures of performance exist and our results only pertain to the narrowly defined stock market return definition of performance.
For both the ABC firms and their matched counterparts, we compute returns
from January 1 in the year of the adoption of ABC. This discrete date was chosen,
in the interests of consistency, as the survey infonnation did not identify the
month of adoption of ABC. We use both three-year average holding period returns
(HPRs) and average cumulative abnormal returns (CARs) to test for difference
between each matched set of firms. The HPR measure is used to overcome the
findings of Conrad and Kaul (1993) and Barber and Lyon (1997), that CAR-based
metrics can lead to biased test statistics in studies of long-term stock performance. The CAR measure (Ritter 1991) is included as a robustness check.
We compute HPRs over the three-year period commencing in the first month of
the year of adoption of ABC as follows:

30

Joumal of Management Accounting Research, 2001

36
t"l

where r^^ is the raw return on company i in event month t.

In this study, HPRs were calculated for each ABC and non-A13C matched firm,
individually. As in Ritter (1991), months are defined as successive 21-trading-day
periods. The paired t-test is then used to test for differences between the holding
period return of the ABC firms and the holding period returns of their matched
non-ABC counterpeuts.
Finally, we also compute wealth relatives (WR), (Ritter 1991) as:
1+ average HPRs of ABC firms
1+ average HPRs of non-ABC firms
A wealth relative greater than 1 implies that the ABC firms outperformed the
portfolio of matched firms and vice versa.
For the CAR method, we proceed as follows. The monthly average abnormal
return for stock i in event month t is defined as:
where r.^ is the return on ABC firm i in month t and r^j is the return on its
matched counterpart in the same month. Note that t = 1 is the first month in the
calendar year of the adoption of ABC.
The monthly average abnormal return on the ABC portfolio for event month t
is the equally weighted cross-sectional arithmetic average of the individual abnormal returns:

We use the simple t-test to determine whether the monthly AR is different from
0, that is, whether ABC firms on average outperform the non-ABC benchmark
firms in month t:
-r
A
where n^ is the number of observations in month t, and sd^ is the cross-sectional
standard deviation of the abnormal returns for month t.
The cumulative abnormal return (CAR) for firm i is the summation of the
average abnormal return from event month q to event month s:
t=q

The CAR is cross-sectionally averaged and the t-statistic for the cumulative
average abnormal return from month 1 to month t is computed as (Ritter 1991):
1

where: C A R i t = ^
n^ = the number of firms trading in each month;
t (t.var + 2 (t- 1) cov)^/^.
t = the event month;
var = the average (over 36 months) of the monthly cross-sectional
variances; and
cov = the first-order au toco variance of the AR^ series.

Kennedy and Affleck-Graves

31

RESEARCH FINDINGS
Table 5 contrasts the performance of the ABC firms with that of their non-ABC
matched counterparts. Results are presented for the HPR and CAR methods, as
well as a nonparametric test of the proportion of ABC firms that outperformed
their matched counterparts. Using the HPR method, the ABC firms clearly outperform their matched counterparts in the three years commencing with the year of
the introduction of ABC. Over this period, the ABC firms average approximately 61
percent return (58.66 percent to 63.24 percent depending on the sample used) in
contrast to the approximately 34 percent (30.32 percent to 36.02 percent) earned
by their matched counterparts. This 27 percent difference, on average, is statistically significant in all cases (at the 0.05 level).
The CAR method confirms the above results, with the ABC firms outperforming
their non-ABC counterparts, by approximately 25 percent, on average, over the
three-year period. The nonparametric test of proportions confirms that in most
samples, the percentage of ABC firms that outperform their matched counterparts
is above 60 percent and is statistically larger than 50 percent at the 0.10 level in
four of the six cases. Finally, wealth relatives that range from 1.16 to 1.25 indicate
the magnitude of the difference in performance over the three-year period.
Figures 3, 4, and 5 highlight the magnitude of the positive difference in favor
of the ABC firms over the 36 months. The largest positive abnormal returns are
observed in the last 12 months of the study period in each case. A possible reason
for this is the complexity of an ABC system and the lengthy time frame required
for full implementation. This may lead to a delay between implementation and the
realization of the benefits in the stock price.

ROBUSTNESS TESTS
We provide four additional robustness checks to show that the superior returns earned by the ABC firms are not a result of our matched sample method.
First, we compare the performance of the ABC firms with that of the FTSE-100
index, a broad-based market index. Second, we track the performance of the ABC
firms and their matched counterparts in the two-year period prior to the adoption
of ABC. Third, we provide a comparison between the ABC and the non-ABC firms
for a number of accounting-based measures of performance. Finally, we compare
the occurrence of other strategic initiatives such as new capital raised, acquisitions, and divestitures for the ABC and the non-ABC firms both before and after
the adoption of ABC.
Table 6 compares the post-adoption performance of the ABC firms with the
FTSE-100 index. In this case, the HPR for the FTSE-index was computed over the
same 36 months as that used to compute each ABC firm's HPR. The results are
very similar to those found using the matched-firm approach. In summary, the
ABC firms outperform the FTSE index by approximately 20 percent over the three
years beginning on January 1 of the year that ABC is first adopted. This difference
in performance is statistically significant in all cases, at the 0.05 level. In addition,
approximately 60 percent of the ABC firms outperform the FTSE-index over the
three-year period and the wealth relative is in the order of 1.14.
Failure to capture risk differences could explain the superior performeince of our
ABC firms. To address this possibility, we contrast the performance of these firms
over a different time period. The period chosen is the two-year period prior to the
first year that ABC was adopted by the ABC firms. The results in Table 7 show
little difference in performance between the two groups during this two-year period.
The difference in abnormal returns is between -7 percent and +5 percent, depending on the sample used, and is never statistically significant at conventional levels.

Joumal of Management Accounting Research, 2001

32

FIGURE 3
Monthly HPRs of ABC Firms vs. Non-ABC Firms
Market Capitalization Sample
0.7(X)0 .
0.6000 0.5000 0.4000
0.3000 0.2000 0.1000
0.0000

ABC Fitms

FIGURE 4
Monthly HPRs of ABC Firms vs. Non-ABC Firms
Market-to-Book Sample
0.7000
0.6000
0.5000
0.4000
0.3000
0.2000
0.1000
0.0000

-1

ABC Firms

FIGURE 5
Monthly HPRs of ABC Firms vs. Non-ABC Firms
Net-Total-Assets Sample
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Kennedy and Affleck-Graves

33

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Joumal of Management Accounting Research, 2001

The proportion of ABC firms that outperformed their matched counterparts is

between 43 percent and 56 percent, again not statisticaliy significant at conventional levels. Finally, the wealth relatives are between 0.94 and 1.04. We believe
this similar performance over the two-year pre-event period shows that our results
are not purely the result of methodological problems, such as a failure to adequately adjust for risk differences.
Our third robustness check is to determine whether our ABC-adopting firms
have superior operating performance in addition to the superior stock return
performance we document above. Many recent studies have used accountingbased performance tests to confirm the under- or overperformance found in stock
market returns. Barber and Lyon (1996, Table 1) provide a comprehensive list of
11 recent studies using this approach. They also conduct an extensive simulation
study to determine the most appropriate statistical procedures for tests of accounting performance. Their three major conclusions are:
(1) due to the presence of extreme observations, nonparametric Wilcoxon test
statistics are uniformly more powerful than parametric t-tests, regardless
of the operating performance measure used;
(2) test statistics using changes in operating performance relative to a benchmark yield more powerful tests than those based on a firm's relative
performance; and
(3) test statistics are only well specified when sample firms are matched to
control firms with similar pre-event performance.
Barber and Lyon (1996) also express a preference for a performance measure
based on operating income rather than earnings, although they concede that the
choice is generally inconsequential from a statistical standpoint.
Consistent with Barber and Lyon (1996), we report medians rather than means
in Table 8 and use a Wilcoxon paired test based on changes in accounting performance rather than the relative performance. We also note that our evidence of no
difference in the prior period returns of our ABC firms relative to their matched
counterparts has added importance in light of Barber and Lyon's (1996) third
recommendation (item (3) above). Finally, our major focus is on two measures of
accounting performance, return on shareholders equity (earnings-based) and operating profit margin (operating-income-based), although we report several other
accounting-based m.easures in an attempt to determine the drivers of the difference we observe in stock market performance.
A review of the accounting-based measures of performance in Table 8 confirms
the superior performance of the ABC firms. In particular, this superior performance is statistically significant for the operating and net profit margins and for
the asset turnover ratio in most of the samples we examine (at the .10 level or
better). The debt ratio comparison suggests that the ABC firms adopt and sustain
a significantly higher leverage profile than the non-ABC firms. Taken together, the
accounting ratios suggest that the cost control, asset utilization, and financial
management characteristics of the ABC firms all contribute to the superior performance of the ABC firms.
Finally, we searched for evidence of other significant corporate events in the
year preceding and the three years following the adoption of ABC for both our ABC
firms and their matched counterparts. The motivation for this inquiry was to
address concems that the superior performance of the ABC firms may be due to
confounding contemporaneous management innovations, such as new capital
raised, acquisitions, and divestitures. Our source for this published information is

Kennedy and Affleck-Graves

35

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the Global Access online database provided by Primark. Table 9 tabulates our
results for these three important strategic initiatives. It documents both the number of firms engaged in each activity and the dollar value of the activity expressed
as a percentage of the firms' market capitalization. There is no evidence of significant differences between the number of our ABC firms and the number of nonABC firms that are engaged in these three activities, either before or after the
adoption of ABC. {Note that the higher number of firms in the post-ABC period is
due to the three-year period as compared to the one-year pre-ABC period that we
examine.) Similarly when we examine activity as a percentage of each firm's
market capitalization, we fmd no differences between the ABC firms and their
matched counterparts, either before or after the introduction of ABC.
We also read the Chairman eind Chief Executive's annual report for the majority of our ABC and non-ABC firms. There are several consistent themes in these
reports, including regional development, some element of re-organization and staif
changes, changes in directors, encouraging trade performance, increased emphasis on marketing and new product development, emphasis on maximizing shareholder value through long-sighted programs of organic growth coupled with carefully chosen acquisitions, etc. We were, however, unable to discern any marked or
obvious differences between the ABC and non-ABC firms.
While we have not examined all possible extraneous events that may be the
underl5dng cause of the superior performance we document for our ABC sample,
the above analysis indicates very little difference between our ABC firms and their
matched counterparts in terms of several important strategic actions. Nevertheless, we cannot rule out the possibility that some unidentified correlated variable
is the cause of our results.
Finally, this study asked firms to rate their experience of introducing the ABC
techniques. We found that a substantial majority at 77 percent (n = 36) considered
the experience to have been successful. This is consistent with Innes and MitcheU
(1995) at 69 percent (n = 34) and the 3.9 Likert scale rating (with 5 being very
successful) reported by Innes et al. (2000). It is also consistent with a number of
studies (for example. Shields 1995; Swenson 1995; Shields and McEwen 1996;
Krumwiede 1998; Anderson and Young 1999) that have used key organizational
and social variables to measure the success of ABC implementation. Despite the
considerable variation in the degree of success reported by these studies, on average, firms experienced moderate levels of success emd perceived a financial benefit
fi-om the adoption of ABC. Worth noting is the possibility that respondents fi-om
ABC-adopting firms may be exhibiting biased discrimination in their judgment.

SUMMARY AND INTERPRETATION

We provide empirical evidence that the adoption of ABC significantly improves a
firm's relative performance in terms of both market- and accounting-based measures. The magnitude of this improved market performance is both economically
and statistically significant, averaging approximately 27 percent above the matched
non-ABC firms over the three years beginning on Jeinuaiy 1 of the year in which
ABC is first adopted. While large, this 27 percent superior perfoimance is not
dissimilar in magnitude to abnormal returns documented in other studies. For
example, Ritter (1991) documents three-year underperformance of gceater than 27
percent following initial public offerings, Spiess and Affleck-Graves (1995) document greater than 42 percent underperformance by firms following seasoned equity
offerings, and Ikenberry et al. (1995) document positive overperformance of greater
than 12 percent in the two years following stock repurchases. Further, our evidence
shows that the superior stock performance of the ABC firms is not immediate, but
took until the second half of the three-year study period to manifest itself.

Kennedy and Affleck-Craves

37

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Joumal of Management Accounting Research, 2001

Our evidence of superior performance for ABC-adopting firms provides tangential support for two other studies related to the impact and benefits of ABC.
First, Malmi (1999) explores four possible reasons for adopting ABC: efficient
choice, forced selection, fads, and fashion. Superior subsequent performance
suggests that the adopting firms made a rational value-enhancing choice when
adopting ABC. Consequently, our results provide support for Malmi's (1999) evidence in favor of the efficient choice hypothesis, although we are unable to determine if this is limited to the early adopters ("take-off stage) as he suggests.
Second, Shields and McEwen (1996) report that 75 percent of responding companies report a financial benefit from implementing ABC. Our evidence of superior
stock returns following adoption suggests that the companies' perception of financial benefit is justified.
In contrast to the support for the above studies, our results do not clarify
Gosselin's (1997) ABC paradox, but rather accentuate it. If ABC-adopting firms
have better stock performance in addition to the other benefits cited in the literature, then why have more firms not implemented the approach? Moreover, why do
many firms that adopt ABC stop using it? While none of our survey firms indicated
that they had introduced and subsequently abandoned ABC, Ness and Cucuzza
(1995) suggest that only 10 percent of firms that adopt ABC continue to use it.
This is clearly inconsistent with our value-enhancing evidence and we are unable
to shed further light on Gosselin's (1997) paradox.
Our results are also somewhat inconsistent with those in Gordon and Silvester
(1999). Using a sample often U.S. firms, they find no evidence of an increase in
firm value associated with the announcement that the firms are ABC users. Our
tests, however, have several advantages over the Gordon and Silvester (1999)
approach. First, we have a much larger sample. Second, our sample does not have
the extreme event-clustering present in the Gordon and Silvester (1999) study.
Both of these should lead to more powerful test statistics. Third, we examine longterm performance and, hence, we do not require an exact announcement date or
that the market immediately and fully understands the implications of the ABC
adoption (Gordon and Silvester 1999, 236). Combining these two market-based
studies, we can conclude that there is no evidence that the adoption or use of ABC
leads to a decrease in firm value as suggested in a worst-case scenario by Bromwich
and Bhimani (1989) and Dopuch (1993).
There are many important limitations and caveats to our study. First, there
are several issues related to the sample we use. Our sample is Eimsdl (33 to 38
firms), which limits the power of the statistical tests. It is, however comparable to
simileir studies (for example, Haka et al. [1985] use 30 firms, while Easton and
Jarrell [1998] have a sample of 108 TQM firms). The small sample size also makes
our results sensitive to the selection of our sample firms and their matched
counterparts. In addition, we use a survey method that allows firms to self-report
the adoption of ABC and this may bias our sample to certain types of firms. We
attempted to limit the impact of these problems through the use of a controlled
matched-pairs design and several robustness checks. However, sample limitations and bias remain a valid concern.
Second, the sample firms have adopted ABC in a wide variety of ways (Friedman and Lyne 1995) and we are not able to classify the degree of implementation
by our ABC firms. In particular, we have no indication of each firm's commitment
to ABC, or the extent to which it is implemented. Shields and McEwen (1996) and
McGowan and Klammer (1997) both indicate that factors such as top management support, compensation, and tredning are important in determining the success of ABC implementation.

Kennedy and Affleck-Graves

39
Third, many factors drive relative stock price performance and the superior
performance we document for ABC firms may be a result of another variable that
is simply correlated with ABC in our sample. Alternatively, as Shields et al. (2000)
suggest, the effects of a system such as ABC may be indirect through the mediating influence of another variable. For example, case study research by Innes and
Mitchell (1990b) shows substantial organizational restructuring is required for the
introduction of ABC. They suggest that this restructuring, rather than the ABC
system per se, is the cause of the superior subsequent performance. Similarly,
Anderson and Young (1999) show that both contextual factors (individual and
organizational) and factors related to the implementation process are associated
with ABC project evaluations and outcomes. In a different context, Haka et al.
(1985) argue that factors such as resource scarcity and reward structure may
confound the relationship between implementation and performance.
Ultimately, no observational study can prove a causal relationship (Easton
and Jarrell 1998). However, we have attempted to mitigate the problems by using
an established research methodology and a carefully constructed control sample.
We also attempt to control for several additional factors in a series of robustness
checks. While it is not possible to examine every potential confounding variable,
we show that our results hold when firms are matched on market capitalization,
market-to-book ratio, or net-total-assets value. We also show that there is no
difference in the performance of the ABC and non-ABC firms in the two years prior
to the adoption of ABC. We regard this as an important test as it suggests there
are no differences in priced risk factors between our sample and the matched
firms prior to the adoption of ABC. We also document superior performance by the
ABC firms using both market- and accounting-based measures. Finally, both
before and after the adoption of ABC, we find no difference in either the frequency
or the magnitude of new capital reused, acquisitions, and divestitures between our
ABC and non-ABC firms.
In conclusion. Cooper and Kaplan (1992) argue that "the goal of ABC is to
increase profits, not to obtain more accurate costs." While the adoption of ABC
usually requires considerable organizational support and can be extremely costly,
the consistency of our results across matching criteria and other robustness
checks, suggests that firms were effective in reaping the net benefits, on average.
The overall results are consistent with an inference that the introduction of ABC
techniques improves firm performance. Nevertheless, despite this evidence, caution must be exercised in extrapolating the results of this study. In particular, it is
not necessarily true that companies that have not implemented ABC can improve
performance by simply introducing ABC techniques. While ABC may provide a
richer information base that leads to new management insights, it is ultimately
management that is responsible for taking new actions that lead to value enhancement. Using our sample and methods, it is very difficult to determine whether
the particular management actions that led to the superior performance of our
ABC firms is due to the information system or some other related factor. Consequently, the factors that drove our sample firms to implement ABC may not be
present in other firms and therefore, the introduction of ABC may not provide
similar benefits to new adopting firms.

Joumal of Management Accounting Research, 2001

40

APPENDIX
Activity-Based Costing (ABC) Techniques Questionnaire
(Confidential
The introduction of Activity-Based Costing (ABC) techniques has met with
mixed success. Some firms have had very successful implementations whilst
others have adopted and later abandoned the approach. This questionnaire is the
basis of a research study aimed at establishing if the introduction of ABC techniques makes a significant difference to firm performance.
ABC is defined by Raffish and Tumey (1991) as "a methodology that measures
the cost and performance of activities, resources and cost objects." The cumulative cost of each activity is then traced to products or services that make that
activity necessary. By so doing ABC recognises the causal relationship of cost
drivers to activities.
Please return the completed questionnaire by using the attached prepaid envelope or fax before
Friday, March 22 to: RESEARCH CENTRE, HENLEY MANAGEMENT COLLEGE. Fax: 01491-571454

.Respondent:

Firm Name:

(optional)

Position in Organisation:
(Please print the above)
1. Has your firm ever used ABC techniques?
Yes

If Yes, Answer Questions 2 to 9.

No

If No, go to Question 10.

2. When were the ABC techniques introduced and what proportion of your firm's
Sales Value, Total Assets and Total Costs were affected by their introduction?
Show multiple introduction dates and data separately, if appropriate.
WHEN
Month

Year

PROPORTION AFFECTED
% of Sales
% of Total
% Total
Value (approx.)
Assets (approx.)
Costs (approx.)

3. Please complete if your firm has used ABC techniques and abandoned them.
WHEN
Month

Year

PROPORTION AFFECTED
% of Sales
Value (approx.)

% of Total
Assets (approx.)

% Total
Costs (approx.)

Kennedy and Affleck-Graves

41
4. Who was involved in the design and implementation of the ABC techniques?
(Tick as appropriate)
Description

Implementation

Design

Consultants
In-house accountants
Production personnel
Systems personnel
Marketing personnel
Any other (please specify)

5. For which of the following purposes were the ABC techniques introduced and
are they still used for that purpose? (Tick as appropriate)
Basis of Decision
to Introduce
Purpose
Stock Valuation
Product Pricing
Product Output Decisions
Cost Management and Reduction
Cost Budgeting
New Product Design
Customer Profitability Analysis
Performance Measurement
Cost Modelling
Any other purpose (please specify)

Yes

No

Current Use
Yes

No

6. Have the ABC techniques being used? (Tick as appropriate)

Yes

As a parallel system with another costing system

As the main costing system

No

42

Joumal of Management Accounting Research, 2001

7. How would you rate the overall success of the introduction of the ABC techniques in your firm? (Tick as appropriate)
Degree of Success
Very successful
Fairly successful
Neutral
Fairly unsuccessful
Very unsuccessful
8. Did you experience any unexpected outcomes from the inti^oduction of the
ABC techniques?
Yes

No

If yes, please state these outcomes:

9. If you wish to add any further comments about the use of the i\BC techniques
please do so:

10. Into which of the following categories does your firm fall and why? (Ignore if
answered Yes to Question 1)
Category
We have considered using ABC
techniques and rejected them.

Yes

No

Why (optional)

We are currently considering

using ABC techniques.
We have not considered ABC
techniques.

Thank you for helping me with this research study.

Kennedy and Affleck-Graves

43

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